Jim Cramer: Don't just save - invest
Uncertain about which way to turn in today's unsettled economy? Some suggestions now from Jim Cramer of CNBC's "Mad Money."
This story was originally broadcast on March 23, 2014.
If you want to achieve real financial independence, then your paycheck is not going to be enough. And contrary to what you might believe, saving isn't enough, either. For true independence, you need to invest your money so that it grows year after year.
But, in concrete terms, how do you actually go about managing your money?
First of all, there's two different kinds of investing, and that's why you should have two different portfolios. You've got your retirement portfolio -- pretty self-explanatory -- where you want to keep money in tax-favored vehicles, like a 401(k) plan or an Individual Retirement Account (IRA for short).
You don't pay a cent of income tax for contributions to a 401(k) or IRA, and until you withdraw the money, you don't pay any dividend or capital gains taxes, either. Your cash is only taxed once, as regular income, when you ultimately withdraw it. Total no-brainer.
But here's the rub: if you withdraw money from a traditional 401(k) or IRA before you turn 59-and-a-half, you get hit with a major penalty. So that's where your second portfolio comes in, what I call your discretionary portfolio -- just use a cheap discount broker with low commissions for this one.
Your discretionary portfolio is about creating wealth that you can actually use while you're still young enough to enjoy it. Retirement comes first, though -- I recommend saving 10-15 percent of your income, with two-thirds of that for retirement investing. The rest you can play with in your discretionary fund.
You should be more conservative with your retirement portfolio, and take more risks in your discretionary one, but there's one rule that holds true for both: always be diversified.
This sounds simple, but it takes discipline. In short, you're diversified when no more than 20 percent of your portfolio is in the same sector (the same area of the economy). That way if something happens to crush one group of stocks (like the tech crash in 2000, or the financial crisis starting in 2008), it won't eviscerate your entire portfolio.
So any diversified portfolio needs a minimum of five stocks.
What would a diversified portfolio look like? How about one oil stock, like EOG Resources; one new tech play, like Google; one industrial, like Johnson Controls; one retailer, like Costco; and one healthcare stock -- either a biotech like Gilead, or for a more conservative approach a big pharma name, like Merck.
If you want to make it six stocks, throw in an entertainment company, like Disney.
My philosophy for beating the market is buy and homework, meaning you need to keep up with the companies you own. Most importantly, read the SEC filings, especially the annual report, and listen to the quarterly conference calls, both of which you can do on the Internet.
If you don't have the time or inclination to pick individual stocks, by all means put your money in a low-cost Standard & Poors 500 index fund.
Bottom line: Don't just save; invest.
And remember, always stay diversified, both in your tax-favored retirement portfolio and in your discretionary account.
For more info:
- Jim Cramer's "Mad Money" (CNBC)
- Jim Cramer at the street.com
- Action Alerts PLUS at thestreet.com
- Jim Cramer's blog at realmoney.com
- "Jim Cramer's Get Rich Carefully" (Blue Rider Press); also available in eBook and Unabridged Audio CD formats